Estimating Money Demand Function by a Smooth Transition Regression Model: An Evidence for Turkey

Sahin, Afsin (2013): Estimating Money Demand Function by a Smooth Transition Regression Model: An Evidence for Turkey. Published in: Athens, and ATINER's Conference Paper Series No. No. MDT2013-0382. (29 April 2013): pp. 1-19.

Abstract

The money supply process is assumed to be fixed in economic literature or at least there is a central bank trying to control the liquidity in the economy. On the other hand, the demand side is more volatile and more uncertain. This situation hinders the homogenous and symmetric information assumptions of the monetary models. The amount of money demanded is a dynamic process and changes depending on the transition variable in concern. The money demand increases in the boom periods of the economy but may diminish in the recessions gradually. Therefore the money demand function indicates an asymmetric behavior and nonlinearity. This paper estimates the money demand function by including the inflation uncertainty, that is assumed to be a transition variable for a small-open economy, Turkey by using the monthly data spanning from January, 1990 to May, 2012. The parameters of the money demand function are estimated by the Smooth Transition Regression (STR) models. While modelling the nonlinearity, an appropriate logistic function is determined. The dependent variables that are used to estimate the money function are gold, interest rate, inflation uncertainty, share prices, exchange rate and income. The inflation uncertainty data is gathered from the conditional variances of a specified EGARCH model. The results of the paper have several policy implications for the monetary authorities. First, the behavior of the money demand and its determinants are crucial at the times of adopting the inflation targeting regime. The stability of money demand is also related to the stability of inflation. So the results of the paper may be beneficial for the policy makers and monetary authorities during their decision making process.

• Item Type: MPRA Paper
• Language: English
• Keywords: Money Demand; Inflation Uncertainty; Smooth Transition Regression; Nonlinearity.
• Subjects: C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C58 - Financial Econometrics; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E41 - Demand for Money; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E51 - Money Supply ; Credit ; Money Multipliers

References

Altıntaş, H. (2008). 'The stability of money demand in Turkey and predicting with nound testing approach: 1985-2006.' Erciyes Üniversitesi İktisadi ve İdari Bilimler Fakültesi Dergisi 30(Jan.): 15-46. [In Turkish.]

Asilis, C.M., P. Honohan & P.D. Mcnelis (1993). 'Money demand during hyperinflation and stabilization: Bolivia, 1980-88.' Economic Inquiry 31(2): 262-273.

Austin, D., B. Ward & P. Dalziel (2007). 'The demand for money in China, 1987-2004: A nonlinear modelling approach.' China Economic Review 18(2): 190-204.

Bailey, M. J. (1956). 'The welfare cost of inflationary finance.' Journal of Political Economy 64(2): 93-110.

Ball, L. (2001). 'Another look at long-run money demand.' Journal of Monetary Economics 47(1): 31-44.

Belke, A. & T. Polleit (2009). Monetary economics in globalized financial markets. New York: Springer.

Blanchard, O. (2011). Macroeconomics. Updated Fifth Edition, UK: Pearson Education.

Blejer, M. I. (1979). 'The demand for money and the variability of the rate of inflation: Some empirical results.' International Economic Review 20(2): 545-549.

Bocutoğlu, E. (2011). Comparative macroeconomics: Theories and policies. Extended 4th Edition, Trabzon: Murathan Publication House. [In Turkish].

Bofinger, P. (2001). Monetary policy goals, institutions, strategies, and instruments. New York: Oxford University Press.

Boughton, J. M. (1981). 'Recent instability of the demand for money: An international perspective.' Southern Economic Journal 47(3): 579-97.

Buscher, H. & S.F. Frowen (1993). 'The demand for money in Japan, the United Kingdom, West Germany and the USA: An empirical study of the evidence since 1973.' In: S.F. Frowen (ed.), Monetary theory and monetary policy, new tracks for the 1990s, 123-165. New York: St. Martin’s Press.

Calvo, G. & C. Reinhart (2000). 'Fear of floating.' NBER Working Paper, No. 7993, November.

Calza, A. & A. Zaghini (2011). 'Sectoral money demand and the great disinflation in the US.' Banca D'Italia Working Paper, No. 785: 1-32.

Chen, S.L., J.L. Wu (2005). 'Long-run money demand revisited: Evidence from a non-linear approach.' Journal of International Money and Finance, 24(1): 19-37.

Demiralp, S. & Carpenter, S. (2008). The role of money in the transmission mechanism. TÜBİTAK Project No. 106K226. [In Turkish].

Deschamps, P.J. (2008). 'Comparing smooth transition and markov switching autoregressive models of US unemployment.' Journal of Applied Econometrics 23(4): 435-462.

Dijk, D., Terasvirta, T. & Franses, P.H. (2002). 'Smooth transition autoregressive models: A survey of recent developments.' Econometric Reviews 21(1): 1-47.

Dönmez, O. (2007). 'The Fisher equation examined: Implications for the money demand in Turkey.' Central European University, Department of Economics Masters Thesis, Hungary.

Dreger, C. & J. Wolters (2010). 'Investigating M3 money demand in the Euro area.' Journal of Intenational Money and Finance 29(1): 111-122.

Enders, W. (2010). Applied Econometric Time Series. USA: John Wiley.

Escribano, A. & O. Jorda (2001). 'Testing non-linearity: decision rules for selecting between logistic and exponential STAR models.' Spanish Economic Review 3(3): 193–209.

Escribano, A. & O. Jorda (1999). 'Improved testing and specification of smooth transition regression models.' In: P. Rothman & P. Dordrecht (eds.), Nonlinear time series analysis of economic and financial data, 289-320. USA: Kluwer Academic Publishers.

Friedman, M.B. (1994). 'Intermediate targets versus information variables as operating guides for monetary policy.' In: J.A.H. Wijnholds, S.C.W. Eiffinger and L.H. Hoogduin (Eds.), A framework for monetary stability, 109-133. USA: Kluwer Academic Publishers.

Franses, P.H. & D. Dijk (2003). Non - linear time series models in empirical finance. New York: Cambridge University Press, Cambridge, 69-132.

Goldfeld, S. (1973). 'The demand for money revisited.' Brookings Papers on Economic Activity 4(3): 577-638.

Granger, C.W.J. & T. Terasvirta (1993). Modeling non-linear economic relationships. Oxford: Oxford University Press. Gujarati, D. (1968). 'The demand for money in India.' Journal of Development Studies 5(1): 59-64.

Hasan, M. S. (2011). 'Seasonal cointegration and long - run neutrality of money in the USA.' Review of Banking, Finance and Monetary Economics 40(3): 93-105.

Hetzel, R. & Y. Mehra (1989). 'The behaviour of money in the 1980s.' Journal of Money, Credit and Banking 21(4): 45-463.

Ingbank (2012). 'Research on saving tendencies of Turkey: Comparative results for the 2011 4th quarter and 2012 first quarter.' ING BANK. [In Turkish].

Inguva, S. (1978). 'The demand for money and inflationary process: An econometric model.' Ph.D. diss., Georgia State University, Department of Economics.

Issing, O., V. Gaspar, O. Tristani & D. Vestin (2005). Imperfect knowledge and monetary policy. Cambridge: Cambridge University Press.

Kapetanios, G., Y. Shin & A. Snell (2003). 'Testing for a unit root in the nonlinear STAR framework.' Journal of Econometrics 112(2): 359-379.

Keyder, N. & E.İ. Ertunga (2012). Money, theory, policy and application. 12th edition, Ankara. [In Turkish]. Keyder, N. (2008). Money, Theory, Policy, Application, Ankara. [In Turkish].

Khan, A.H. (1982). 'The demand for money and the variability of the rate of inflation.' Economics Letters 10(3): 257-261.

Klein, B. (1977). 'The demand for quality-adjusted cash balances: Price uncertainty in the U.S. demand for money function.' Journal of Political Economy 85(4): 691-715.

Korap, L. & M. Yıldırım (2012). 'Testing the Lucas Critique for the money demand function.' İktisat, İşletme ve Finans 27(318): 57-82.

Kratzig, M. (2004). 'STR Analysis in JMulti.', March, 1-17.

Lin, C.F.J & T. Terasvirta (1994). 'Testing the constancy of regression parameters againist continous structural change.' Journal of Econometrics 62(2): 211-228.

Lovell, M.C. (2006). Economics with calculus. USA: World Scientific, pp. 465-486.

Lundbergh, S. & T. Terasvirta (2002). 'Forecasting with smooth transition autoregressive models.' In: M.P. Clements and D.F. Hendry (eds.), A Companion to Economic Forecasting, 485-509. USA: Blackwell Publishing.

Luukkonen, R., P. Saikkonen & T. Terasvirta (1988). 'Testing linearity againist smooth transition autoregressive model.' Biometrika 75(3): 491-499.

Martens, M., P. Kofman & T.C.F. Vorst (1998). 'A threshold error-correction model for intraday futures and index returns.' Journal of Applied Econometrics 13(3): 245-263.

Mayer, T. (1993). 'Monetarism in a world without money.' In: S.F. Frowen (ed.), Monetary theory and monetary policy, new tracks for the 1990s, 43-79. USA: Martin’s Press.

Mizrach, B. & A.M. Santomero (1990). 'A liquidity in advance model of the demand for money under price uncertainy.' Journal of Monetary Economics 26(1): 143-159.

Slavova, S. (2003). 'Money demand during hyperinflation and stabilization: Bulgaria, 1991-2000.' Applied Economics 35(11): 1303-1316.

Lütkepohl, H., T. Terasvirta & J. Wolters (1999). 'Investigating stability and linearity of a German M1 money demand function.' Journal of Applied Econometrics 14(5): 511-525.

Michael, P., Nobay, R.A. & D.A. Peel (1999). 'Nonlinear adjustment towards long-run money demand.' In: P. Rothman (ed.), Nonlinear time series analysis of economic and financial data, 179-190. USA: Kluwer Academic Publishers.

Ordonez, J. (2003). 'Stability of non-linear dynamics in the broad demand for money in Spain.' Economics Letters 78(1): 139-146.

Özdemir, K.A. (2011). 'Overlook on the monetary analysis: An evidence for Turkey.' Central Bank Review 11(7): 29-48. [In Turkish].

Pavlidis, E.G., I. Paya & D.A. Peel (2009). 'Specifying smooth transition regression models in the presence of conditional heteroskedasticity of unknown form.' Lancaster University Management School WP 2009/09.

Poole, W. (1970). 'Whither money demand.' Brookings Papers on Economic Activity 1(3): 485-501.

Rao, B.B. & R. Singh (2006). 'Demand for money in India: 1953-2003.' Applied Economics 38(11): 1319-1326.

Sarno, L. (1999). 'Adjustment costs and nonlinear dynamics in the demand for money: Italy, 1861-1991.' International Journal of Finance and Economics 4(2): 155-177.

Sensier, M., D.R. Osborn & N. Özal (2002). 'Asymmetric interest rate effects for the UK real economy.' Oxford Bulletin of Economics and Statistics 64(4): 315-339.

Skalin, J. & T. Terasvirta (1999). 'Another look at Swedish business cycles, 1861-1988.' Journal of Applied Econometrics 14(4): 359-378.

Terasvirta, T. (2004). 'Smooth transition regression modeling.' In: H. Lütkepohl, M. Kratzig (eds.), Applied time series econometrics, 222-242, Cambridge: Cambridge University Press.

Terasvirta, T. (2004). 'Smooth transition regression modelling.' In: Lütkepohl, H. and Kratzig, M. (eds.), Applied time series econometrics, Cambridge: Cambridge University Press.

Terasvirta, T. (1998). 'Modelling economic relationships with smooth transition regressions.' In: A. Ullah and D.E. Giles (eds.), Handbook of applied economic statistics, 507-552. New York: Marcel Dekker.

Terasvirta, T. (1994). 'Specification, estimation and evaluation of smooth transition autoregressive models.' Journal of the American Statistical Association 89(425): 208-218.

Tunay, B.K. (2001). 'Estimation of income velocity for Turkey by MARS method.' ODTÜ Gelişme Dergisi 29(3-4): 431-434.

Tunca, Z. (2011). Macroeconomics. 5th edition, İstanbul: Geçit Publication House. [In Turkish].

Wang, Y. (2011). 'The stability of long-run money demand in the United States: A new approach.' Economics Letters 111(1): 60-63.

Weintraub, R.E. (1970). Introduction to monetary economics. New York: The Ronald Press Company.

Wolters, J., Terasvirta, T. & H. Lütkepohl (1998). 'Modelling the demand for M3 in the United Germany.' The Review of Economics and Statistics 80(3): 399-409.

Wu, J.L. & Y.H. Hu (2007). 'Currency substitution and nonlinear error correction in Taiwans’s demand for broad money.' Applied Economics 39(13): 1635-1645.

Yashiv, E. (1994). 'Money demand in a high inflation economy: The case of Israel.' The Review of Economics and Statistics 76(1): 186-191.